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Accrued interest is a type of interest that accumulates over a time period but hasn’t yet been paid. That interest could be paid to a lender (such as on a credit card balance or a loan) or an investor (say, on a bond you bought). It’s different from regular interest, and it’s a basic but important financial topic to understand.

So we’ll break it down for you here and share:

•   What is accrued interest

•   How accrued interest works

•   Why it’s important

•   How to calculate accrued interest

What Is Accrued Interest?

When you are investing and earning interest, you’ll probably encounter accrued interest. And in the opposite situation, if you borrow money and owe interest payments, you’ll also bump into accrued interest.

This type of interest accrues in between payments; it’s just a matter of time before it is paid out. Let’s say you have a balance of $1,000 on your credit card, and you make a partial payment on the 30th of the month. Once you make that payment, the remaining balance and any new charges will begin to accrue interest. It will be due on the 30th of the following month. Think of accrued interest as interest that is building up, bit by bit, until that payment is made (or, in the case of investments, until a payout is made).

How Does Accrued Interest Work?

It’s possible to owe accrued interest on a variety of lending products, like the credit card we mentioned above. It’s also possible to earn accrued interest on investing products and savings accounts.

Whenever someone is borrowing money, they owe interest. They are paying for the privilege of using someone else’s money. On the flip side, when they give a financial institution, government agency, or company money to borrow for an investment such as a bond, then the investor is owed interest.

Now that you understand that concept, let’s look a bit deeper. With installment loans, such as a line of credit, interest typically accrues daily. At the end of the month, the interest accrued is added to the total monthly payment amount. With credit cards, the same daily accrual happens after the card holder makes a charge with their plastic. The interest is building up as the month goes on. How much interest accrues depends on the balance of the lending product and the interest rate. Of course, if the balance gets paid off in full, interest won’t be accruing (not until the next charge is made, at least).

Accounts that earn interest, such as certificates of deposits and high-yield savings accounts, also tend to accrue interest daily. The amount of interest accrued is based on the account’s average daily balance. An exception: bonds, which generate a fixed interest payment on a quarterly, semiannual, or annual basis.

Recommended: How Do Credit Card Payments Work?

Example of How Interest Can Accrue

Let’s look at an example of how interest can accrue.

•   Acme Corp took out a loan of $200,000 with a bank at an annual interest rate of 10%.

•   This loan will mature within one year, and any remaining principal and interest payments will be due in full at that maturation date.

•   Acme Corp must make monthly interest payments based on the annual interest rate they received from the bank.

•   During the life of this loan, Acme Corp will owe $54.79 in interest on a daily basis for that 365-day loan term.

•   The accrued interest will be due once a month and will accumulate to $1,666.67.

•   This accumulated interest is what is known as accrued interest. Once Acme Corp pays it off at the end of the month, the amount of accrued interest owed will reset to zero and begin to accumulate again.

Accrued Interest vs Regular Interest

So, what is the difference between accrued interest and regular interest (the latter is sometimes known as simple interest, as opposed to compound interest)? Accrued interest typically indicates interest charges that have accumulated but not yet been paid. Perhaps you have heard the term in this context with student loans: The interest may start accruing (adding up) when the loan is disbursed, but it could only become due at your studies’ completion. You may not be paying the interest just yet, but you can know the interest will be assessed.

Regular interest refers to the interest earned on, say, a home loan. Your payment plus interest is due on a certain date and is not accruing day after day or varying. The “regular interest” involves a known principal and interest rate, as well as a constant monthly payment that is due every month.

Why Is Accrued Interest Important?

Accrued interest matters because it illustrates how interest that a consumer owes or is owed adds up. For example, with bonds, it can help you understand the interest that’s collecting so you can make sure you are earning the right amount. Or, if you have borrowed money, you can look at how the accruing interest will impact your future financial health.

If someone sees how long it will take to pay off a credit card balance over three years, they may want to crunch the numbers on how much interest they will accrue in the next couple of years. They may find that paying the debt ASAP saves them a lot of money. They could figure out how to part with a large chunk of cash at once to avoid the accrual of interest.

Do I Have to Pay Accrued Interest?

The answer to the question “Do I have to pay accrued interest” is yes. Once someone enters a borrowing agreement, they need to pay any interest they accrue. That being said, there are ways they can avoid paying accrued interest altogether or can avoid paying more accrued interest than they need to.

Here’s a few tips for how to minimize accrued interest payments.

•   Pay credit cards in full. Interest accrues whenever you make a purchase with their credit card. But if you pay it off in full by the due date, you won’t need to pay any accrued interest.

•   Make more frequent payments. To minimize how much accrued interest someone owes, you can make additional payments on top of their regularly scheduled minimum payments. Paying down the principal faster on, say, a loan, will lower how much interest accrues on a monthly basis. You may then be able to pay off the loan early, which also helps avoid more interest accruing.

•   Build your credit history. Working on improving your credit score can help you obtain lower interest rates in the future. If you qualify for a better (lower) interest rate when taking out a loan, the amount that accrues on the principal will be lower.

•   Have a plan for your debt payoff. If you are juggling multiple sources of debt, you can pay down the debt faster by having a plan in place. You may want to consider the debt avalanche method or debt snowball method.

•   Refinance your loan. It’s possible to refinance certain loans like home, auto, and student loans. If you’ve improved your credit score, you may qualify for better interest rates and terms since they first took out the loan. This can help lower the amount of accrued interest you owe and help you pay off the debt faster.

Recommended: When Do Student Loans Accrue Interest?

How to Calculate Accrued Interest

How interest accrues varies by the lender and product that’s generating the interest, which could be a loan, a line of credit, an investment product, or a high yield bank account.

For example, to calculate how much interest will accrue with a credit card, all the consumer has to do is divide their APR (annual percentage rate) by 365. If they want to see how much accrued interest they will owe at the end of the month, they will simply multiply that daily amount by how many days are in the statement period. Whenever we talk about credit cards and interest, it’s worth remembering that it’s likely you will make more purchases with your plastic over time. That will boost the amount owed and the interest accrued.

The Takeaway

Accrued interest represents the interest that accumulates in between payments on a financial product. Accrued interest can apply to both lending and investment products, ranging from home loans and credit cards to bonds or savings accounts. Understanding how that interest builds up is a valuable tool. By better comprehending how much you owe or are owed, you can better manage and enhance your financial health.

Looking for a new bank account that earns a superior amount of interest? SoFi is here for you! Open linked Checking and Savings accounts with direct deposit, and you’ll earn a terrific APY. And account holders never have to worry about fees. It’s all part of our plan to help your money grow faster.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

Is accrued interest good or bad?

Accrued interest isn’t necessarily a bad or good thing. If someone borrows money, they may not enjoy paying accrued interest, but it is a part of their lending agreement. On the other hand, if someone earns accrued interest on investments or savings, they’ll probably be pretty happy about it.

Why do I have to pay accrued interest?

Paying accrued interest is more often than not necessary when someone borrows money. Those payments are required by lenders in exchange for lending money to consumers.

What is the difference between interest and accrued interest?

Regular interest represents the payment made in exchange for borrowing money or as a form of income earned from an investment. Accrued interest represents the amount of interest that builds up in between payments.

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SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website .

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A retirement money market account is similar to a savings account where the money is liquid and earns a low interest rate. But a retirement money market account is held within a retirement account such as an IRA or 401(k), and is subject to the benefits and restrictions of those accounts.

While you might have most of your money in higher-return investments, it may also make sense to keep some funds in a retirement money market account. A retirement money market account, like a standard money market account, is a relatively low-risk place to store cash. Even if the return is lower than other investments, it’s predictable.

Another reason to have a retirement money market account is a holding place as you sell investments or transfer money between investments. Here’s what else you need to know about retirement money market accounts.

Recommended: What is a Money Market Account

What Is a Retirement Money Market Account?

As the name suggests, a retirement money market account is a type of money market account that is held inside a retirement account. The money market account could be within a traditional, rollover, or Roth IRA, a 401(k), or other retirement account, which means those funds are governed by the rules of that account.

So the deposits you make may be tax deductible and may grow tax free, but depending on the type of retirement account you might not be able to withdraw funds before age 59 ½ without paying a penalty.

Money in the retirement money market account is liquid. It’s usually where money is held when you first transfer money into your retirement account, or when you sell other investments in your account. You can use the funds in the money market to purchase investments within the retirement account.

What Is a Money Market Fund?

Bear in mind an important distinction: A money market fund, which is technically a type of mutual fund, is different from a money market account. A money market fund is an investment that holds short-term securities (and is not FDIC insured). For example, these funds may hold government bonds, municipal bonds, corporate bonds, cash and cash equivalents.

A money market account is essentially a type of high-yield savings account and it’s FDIC insured up to $250,000.

How Does a Retirement Money Market Account Work?

If you are starting a retirement fund, you’ll want to make sure that you understand how retirement money market accounts work. One big difference from a regular money market account is that money in a retirement money market account is governed by a retirement plan agreement.

This can place some limits on what you can do with the money in a retirement money market account. Typically, that will mean that you can’t withdraw money held in your retirement money market account until you have reached a certain age. But one advantage is that the money in the account will grow tax-free or tax-deferred (depending on what type of retirement account it is in).

For example, a money market account in a Roth IRA would follow different rules than money in a 401(k).

•   You can deduct contributions to a 401(k), but a Roth IRA is funded with after-tax money.

•   You can’t withdraw money from a 401(k) until you’re 59 ½, except under special circumstances.

•   Because contributions to a Roth are post tax, you can withdraw your contributions at any time (but not the earnings).

Advantages of a Retirement Money Market Accounts

•   Money is typically insured by the FDIC up to $250,000.

•   Can store proceeds of the sales of stocks, bonds, or other investments.

•   Many retirement money market accounts offer the ability to write checks against the account.

Disadvantages of a Retirement Money Market Accounts

•   Pays a low interest rate that may not keep up with inflation.

•   Requires a separate retirement account.

•   May not be able to withdraw money until retirement age without paying a penalty.

Retirement Money Market Account vs Traditional Money Market Account

The biggest difference between a retirement money market account vs. a traditional money market account is where they are held. A retirement money market account is held inside a separate retirement account, such as a 401(k) or IRA account. A traditional money market account is usually held at a bank or credit union.

While you can access money in a traditional money market account at any time, you may not be able to access the money in a retirement money market account until you retire. It depends on the type of account.

Recommended: What is an IRA and How Does it Work?

How Does a Retirement Money Market Account Differ From an IRA Account?

While you might think of an IRA as a type of investment account, it may be more accurate to think of an IRA as a collection of various types of investments. You can use your IRA to invest in stocks, bonds, options, real estate, cryptocurrency, and so on.

A retirement money market account is one type of investment that you can have in your IRA. Money in a retirement money market account inside your IRA, for example, can be used for daily living expenses in retirement or as a holding place as you move money between different types of other investments.

In terms of your asset allocation, funds in a money market are considered cash or cash equivalents. This can help balance your holdings that are more volatile.

What Should I Know Before Opening a Retirement Money Market Account?

If you are wondering how to save for retirement, there are a few things that you should know before opening a retirement money market account.

The most important is that money put into a retirement money market account is subject to the same conditions as any other money you invest into a retirement account. You generally will not be able to access it without penalty until you retire.

You also want to bear in mind that these are low-risk, low-return accounts. The money that you deposit, or money that is automatically transferred, is not going to provide much growth.

In some cases, a retirement account might come with a money market account within it, and funds may be automatically deposited there. In these instances, be sure to check that the money in that part of your account is then used to purchase the securities you want. Given the low yield of an MMA, you only want a certain portion of your savings to remain there.

Opening a Retirement Money Market Account

In most cases, you won’t open a retirement money market account separately, as you might with a traditional MMA.

Instead, you would open a retirement account with your bank or company provider. Depending on your IRA custodian, they may automatically include a retirement money market account as an investment option inside your IRA account.

Is a Retirement Money Market Account Right for You?

There are many different types of retirement plans, so you’ll want to make sure to choose the options that make the most sense for you. While it makes sense to have a retirement money market account inside your 401(k) or IRA, you might not want to put much money inside of it.

The reason for this is due to the relatively low interest rate that retirement money market accounts pay. In most cases, the interest rate will be lower than the rate of inflation, so money kept inside of a retirement money market account will lose purchasing power each year.

The one exception to this rule would be retirees who are currently living off of the money in their retirement accounts. These investors already in retirement will often want to keep some of their money in money market accounts so they have to worry less about market volatility.

Alternatives to Retirement Money Market Accounts

There are any number of low-risk alternatives to retirement money market accounts, including vehicles outside a retirement account, such as a high-yield savings. For similar alternatives within a retirement account, you could consider investing in bonds, bond funds, and other options that might provide a steady return, but with a lower risk profile.

The Takeaway

A retirement money market account is similar to a savings account, but it is held inside a retirement account such as an IRA or 401(k). While a retirement money market account has the advantages of being FDIC-insured and fairly liquid, it also doesn’t pay very high interest rates. Most investors will want to keep the money in their retirement accounts in investments that provide higher rates of return, although one advantage of a retirement money market account is that it can become part of the low-risk, cash/cash equivalents part of your portfolio.

Money market accounts are just one option for a secure, steady rate of return. If you’re looking for great interest rates while having flexible access to your money, consider SoFi’s all-in-one high yield bank account. Eligible account holders can earn a competitive APY by signing up for direct deposit.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

What does a retirement money market account require?

A retirement money market account is a type of money market account that is held inside a retirement account, e.g. an IRA or 401(k). You’ll need to open up an IRA or other type of retirement account to have a retirement money market account. Most IRA custodians will include a money market retirement account as one investment option for your IRA.

What is the difference between an IRA and a money market account?

A standard money market account is a liquid investment similar to a savings account. An Individual Retirement Account (IRA) is a tax-deferred account that can be used to invest in a variety of different ways. A money market account inside of an IRA or other retirement account is typically referred to as a retirement money market account.

What is the difference between a money market account and a 401(k)?

A standard money market account is similar to a savings account in that the money is liquid and it pays a fixed rate of interest. A 401(k) is a tax-deferred account that acts as a vehicle for a wide range of investments. Contributions are deductible and the investor must pay taxes on withdrawals. A money market account is funded with after tax dollars, and there are no tax benefits associated with these accounts. A retirement money market account, however, obeys the rules of the retirement account it’s in.

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SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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A Certificate of Deposit (CD) is similar to a savings account, but it comes with a twist: You have to deposit a lump sum in and agree to not touch the money for a specific period of time: e.g. a few months to a few years. The shorter the time period (or term) of the CD, the lower the interest rate it will pay; the longer the term, the more interest you may earn on your money.

These days, though, the difference in the amount of interest you can earn from a long- vs. a short-term CD isn’t always significant. Nonetheless, it’s one of a few factors to consider when deciding which type of CD is right for you.

Certificate of Deposit Overview

A Certificate of Deposit is a type of account offered by most financial institutions, like banks or credit unions. With a CD you make one initial deposit to fund the account, and then your money remains in the account until the end of the term of the CD.

How long does a certificate of deposit last? One big difference between savings accounts and certificates of deposit is that with a savings account, you can deposit or withdraw money at any time. However with a CD you can’t deposit any additional money, and if you withdraw money before the end of the term, you will likely face early withdrawal penalties.

There are some no-penalty CDs on the market that don’t charge a penalty for pulling money out early, but be sure you understand the terms and potential tradeoffs in terms of lower rates or fees.

Recommended: What is a Certificate of Deposit and How Does it Work?

Are CDs Insured?

CDs are typically insured by the FDIC for up to $250,000, which makes them a relatively safe investment. Any money you deposit, up to $250,000, would be covered in the event of fraud or a bank collapse.

If the CD is issued by a credit union, it would be insured for the same amount, by the National Credit Union Administration (NCUA).

There are some CDs that are not federally insured, however, like a Yankee CD (which is a CD offered by the U.S. branch of a foreign bank). Be sure to understand the terms before you open the account.

How Long Are CD Terms?

Back to the question: How long does a certificate of deposit last, generally speaking? All CDs come with a term, and different banks might offer CD investing with different terms. As noted, the longer the term of the CD, generally the higher the interest rate paid out. While there aren’t definitive rules that differentiate between a short-term CD, medium-term CD, and long-term CD, the following is a general guideline:

•   Short-term CDs — 1 year or less

•   Medium-term CDs — 2 to 3 years

•   Long-term CDs — 4 years or more

What Is a Short-Term CD?

A short-term CD is a CD whose term is lower than average, generally 1 year or less. Different banks offer CDs with different terms, but 3-month and 6-month CDs are common.

A short-term CD gives you greater flexibility as you’ll have access to your money sooner than with a longer-term CD. But typically a short-term CD also offers lower interest rates than CDs with longer maturity dates. (Remember that the annual percentage rate or APY is different from the interest rate.)

Why Should I Consider a Short-Term CD?

The biggest advantage of a short-term CD is that it typically pays more than a standard savings account, and you have more flexibility than with longer-term CDs. This can be helpful if you need to save money for a large purchase, when you’d like to earn a steady rate, but you know you’ll need access to the money relatively soon.

Also, with a short-term CD your money is only tied up for a relatively brief period of time, so if interest rates rise and you want to invest elsewhere — or you decide you need your money for some other purpose — you would only need to wait a few months before you could withdraw your money without a penalty.

Advantages of Short-Term Certificates of Deposit

•   Higher interest rate than savings or money market accounts.

•   A relatively safe place to park savings for a big purchase, while earning a steady rate.

•   If rates change or your needs shift, you won’t have to wait long to access your money.

Disadvantages of Short-Term Certificates of Deposit

•   Lower interest rates than medium-term and long-term CDs.

•   You may be able to find higher rates with other financial products (e.g. a high-yield savings account).

Recommended: How Do High Yield Savings Accounts Work?

What Is a Medium-Term Certificate of Deposit?

A medium-term certificate of deposit is a CD whose maturity date is 2 to 3 years. That means that once you invest your money in the CD, you won’t be able to withdraw that money without penalty until the end of the 2- or 3-year period.

Generally medium-term CDs offer higher interest rates than short-term CDs but lower rates than long-term CDs.

Why Should I Consider a Medium-Term CD?

A medium-term CD can make sense if you are saving money for something that won’t happen until a few years down the road.

You’ll want to make sure that you also have an account to store short term savings like an emergency fund. That way, you are less likely to feel the need to withdraw your money before the term of the CD is up.

Advantages of Medium-Term Certificates of Deposit

•   Higher interest rates than short-term CDs.

•   Predictable rate of return with low risk.

Disadvantages of Medium-Term Certificates of Deposit

•   Lower interest rates than long-term CDs.

•   Risk of inflation or interest rates going up while your money is tied up in the CD.

What Is a Long-Term Certificate of Deposit?

Generally speaking, a long-term certificate of deposit is a CD that has a term of 4 years or more. Long-term CDs offer the highest rates of any type of CD, but the rates you’ll earn even with a long-term CD are lower than historical stock market averages. That said, the beauty of CDs is that they offer a predictable rate of return, in a vehicle that’s relatively low risk.

The tradeoff to the higher interest rates that come with long-term CDs is that you won’t have access to your money for several years without paying a penalty.

Why Should I Consider a Long-Term CD?

A long-term CD can be an option if you have money that is set aside for a specific purpose that won’t happen for several years. You might not want to put money that you know you’ll need in the stock market for growth.

Be careful though — if inflation or interest rates rise during the term of your CD, you might find the interest rate on your CD to be not as great as you thought it was.

Advantages of Long-Term Certificates of Deposit

•   Highest interest rates of any type of CD.

•   The predictable rate of return can help balance more volatile investments in your portfolio.

Disadvantages of Long-Term Certificates of Deposit

•   Your money is tied up in the CD for several years.

•   Risk of inflation or interest rates going up while your money is tied up in the CD.

•   You lose out on potential market growth while your money is tied up.

The Takeaway

Investing in certificates of deposit can be a smart way to earn a higher interest rate than you’d typically get from savings or money market accounts. The tradeoff is that most CDs will charge an early withdrawal penalty if you remove your money before the end of the CD’s term, so you have to be willing to lock up your funds for the specific term of the CD you choose (i.e. a few months to a few years).

Generally, CDs with longer terms offer higher interest rates than shorter-term CDs, so make sure to shop around for different rates before opening a CD. You may also be able to find competitive rates with other accounts, like high-yield savings.

Speaking of, if you’re looking for great interest rates while keeping flexible access to your money, consider SoFi’s all-in-one mobile banking app. Eligible account holders can earn a competitive APY when you sign up for direct deposit. That rate can compare favorably to the rates on CDs offered by some banks, and you maintain easy access to your money — without an early withdrawal penalty.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

Which makes more money: a short-term CD or long-term CD?

CD rates vary widely, so if you’re wondering what is a good return on investment for a CD, it can pay to shop around to find the best rates. Most times, you will make more money with a long-term CD compared to a short-term CD.

What happens if you need to withdraw your money from a CD prior to its maturity date?

You’ll get the best returns from your CD if you keep the money in the account until it reaches maturity. But if you do need to withdraw your money before the CD matures, you generally can. You’ll just need to pay an early withdrawal fee — often losing a couple of months’ worth of interest. Check the terms when you open the CD.

How old do you have to be to open a CD account?

To open a CD, you have to be a legal adult, which is usually 18 or 21 years old, depending on the state. Parents can still invest in CDs for their children or other minors, through use of a custodial account.

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SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Photo credit: iStock/AndreyPopov
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Many of us have been in the situation of having our checking account be overdrawn (aka, bouncing a check) and may wonder, “Do I need overdraft protection?” The answer is: It depends. Overdraft protection may suit your financial habits and how your cash flows, but you will most likely literally pay a price for it. According to the Consumer Financial Protection Bureau, Americans pay more than $15 billion in overdraft fees per year.

To help you evaluate if overdraft protection is good for you, learn more about:

•   What is overdraft protection?

•   How much does overdraft protection cost?

•   What are the pros and cons of overdraft protection?

•   What happens if you don’t have overdraft protection?

•   How can you avoid overdraft fees?

What Is Overdraft Protection?

Overdraft protection is a set of measures put in place to ensure you have enough money in your bank account to conduct transactions such as debit purchases and bill payments.

An overdraft on your account means the bank is attempting to make a withdrawal — like an electronic payment or ATM withdrawal — and there aren’t enough funds to cover the amount requested.

If you opted into overdraft protection, the bank authorizes the withdrawal instead of declining it and pays the difference. This can be beneficial in those situations that crop up — say, you get paid tomorrow but don’t have the funds right now for a purchase, or if there’s a lag between your current vs. available balance. You’ll usually be charged a fee in addition to repaying the amount of the overdraft. In other words, you’re borrowing money from the bank to cover the transaction. You’ll need to pay it back by making a deposit to your bank account to get your account balance to zero or above.

This kind of protection gives you a safety net in a couple of ways. It can prevent your defaulting on or making a late payment of bills, while also ensuring that you won’t have your debit card declined.

Overdraft is not the same as non-sufficient funds (NSF). This is when the bank will decline rather than cover the transaction due to the fact that there isn’t enough money in your account. You could be charged a fee for this event as well.

How Much Does Overdraft Protection Cost?

Overdraft fees currently average around $35. However, some banks allow you to link a checking and savings account from the same financial institution so that you have no-fee overdraft coverage when money transfers between these accounts.

In some cases, you may pay overdraft fees multiple times in a day, though many banks limit the number of times you may be charged. For example, if you went to the grocery store and your bill came to $35 and you only had $10 in your bank account, you’ll be slapped with an overdraft fee. Later in the day, if your recurring utilities auto payment was processed, you’d face an additional fee for the bank covering that payment.

Keep in mind that you need to opt into overdraft protection in order for a bank to overdraft your account. That being said, it can depend on the type of transaction — check or recurring electronic payments may not require opt-ins. The bank could be able to charge you an overdraft fee regardless, depending on the fine print of your agreement when you opened your account. It’s best to check with your bank if you’re not sure whether you’ve opted for overdraft protection.

Pros of Overdraft Protection

To help figure out whether you should opt in or not, it’s worthwhile to review overdraft protection pros and cons. This banking service has several benefits, including:

•   Access to funds when an emergency occurs or during an unexpected event. You can write a check, say, for more than you have available, and it will be paid.

•   Can expedite transactions, especially when you’re making a necessary purchase like at the grocery store or gas station.

•   Potentially save you from being embarrassed when a transaction is declined.

•   May help you avoid fees if you link checking and savings accounts from the same bank.

•   Prevent returned check or payment fees from companies, such as utilities companies.

•   Can also prevent late bill payment by covering costs, which in turn can help boost your credit score.

Cons of Overdraft Protection

Although there are perks to opting into overdraft protection, there are also some drawbacks, such as:

•   Paying overdraft fees, possibly multiple charges per day

•   Could encourage you to overspend, knowing the bank will step in and cover you, rather than get better with money

•   Your bank account may not be in good standing if you have a history of overdrafts

Should I Get Overdraft Protection?

If you’re wondering, “Should I get overdraft protection?” the answer is: It depends on what your priorities are.

Sure, it can help to prevent transactions from being declined, especially when you have recurring automatic payments or when you’re paying for necessities, like a tank of gas. It can offer you peace of mind since you don’t have to wonder whether creditors are going to come knocking on your door because of failed payments.

However, this convenience does come at a price, which can add up. Being charged an average of $35 per transaction isn’t pleasant. It can become downright problematic if your account frequently overdrafts. Most people want to avoid paying bank fees, especially when they are this high.

If you’re concerned about making sure you have enough money to cover transactions, you can take measures to prevent your balance from sinking too low. It’s a smart idea to adopt these measures, described below, whether or not you opt into overdraft protection.

What Happens When You Don’t Have Overdraft Protection?

When you don’t have overdraft protection, your bank will typically decline a transaction if you don’t have the funds to cover it. So a check you write would not be paid or a debit card transaction would not go through if the cash isn’t in your checking account.

That being said, each bank will determine what action to take depending on the amount overdrawn and the type of transaction. For instance, if you pay someone a small amount via check and there isn’t enough money in your account, your bank might choose to overdraw your account and charge a fee. Or if you’re swiping your debit card to buy something not too costly, some banks may allow the overdraft and not charge a fee as long as you can cover that amount within a certain amount of time.

Tips for Avoiding Overdraft Fees

Your best bet to not pay any overdraft fees is to take measures to avoid your bank balance dipping below zero. Here are a few best practices to avoid overdraft fees:

•   Turn on the correct bank account alerts to monitor your balance and notify you — either via text, email or push notifications — when your balance is at a certain amount.

•   Download a budgeting app and set up alerts for when you’re overspending.

•   Set reminders for when automatic payments go through or when bills are due so you can deposit funds before those dates.

•   Link your savings and checking account together (check to make sure your bank won’t charge you a fee for this type of overdraft protection).

The Takeaway

Overdraft protection can be useful, but you don’t want to rely on it too frequently. Otherwise, you could pay hundreds of dollars in fees that could go towards other goals. Think carefully about your cash flow and spending habits to decide whether or not it’s right for you and will help you achieve financial fitness.

Luckily, there are financial institutions such as SoFi that don’t charge overdraft fees. This can help you earn, save, and spend responsibly. Banking with SoFi has other advantages as well. If you sign up for our Checking and Savings with direct deposit, you will earn a competitive APY, pay no other account fees, and have access to your paycheck up to two days early.

Start banking smarter with SoFi today.

FAQ

Should I have overdraft protection on or off?

Whether you should opt into overdraft protection is a personal choice. You should weigh some of the factors such as how many fees you are willing to pay, if you are comfortable with declined transactions, and how often you want to check your bank account balance.

Does overdraft protection hurt credit?

Overdrafting your bank account doesn’t hurt your credit score because this activity isn’t reported to the credit bureaus. However, if you link your bank account to a credit card account (for automatic payments, for instance) and you fail to make a payment, your score could be affected.

Do you have to pay back overdraft protection?

Yes, you’ll need to pay back the amount that’s overdrawn, plus an overdraft fee if the bank charges you one.

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SoFi® Checking and Savings is offered through SoFi Bank, N.A. ©2023 SoFi Bank, N.A. All rights reserved. Member FDIC. Equal Housing Lender.
The SoFi Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

Photo credit: iStock/Prostock-Studio
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Commercial banks provide financial services for small and large businesses, including checking and savings accounts, loans, lines of credit, letters of credit, underwriting, and payment processing. These services enable businesses to operate in domestic and international markets. What’s more, financing from commercial banks enable businesses to grow and drive the domestic economy.

Commercial banks are focused on supporting business’ financial needs, but they may also offer services to individuals (this is usually called retail banking). Read on to learn more about what’s unique about commercial banking, including:

•   What is commercial banking?

•   How does commercial banking work?

•   What are commercial vs. investment banks?

•   What are commercial vs. retail banks?

•   What are the benefits of commercial banks?

What Is Commercial Banking: A Definition

Commercial banking is defined as a financial institution that is dedicated to serving businesses. This differs from retail banking, which provides personal banking services to individuals. Typically, a commercial bank offers businesses everything from deposit accounts, loans, and lines of credit to merchant services, payment processing, international trade services, and more. In these ways, a commercial bank can be a vital partner in helping a business succeed and grow.

While commercial banks offer a suite of services for medium and large businesses, small and new business owners can also take advantage of their offerings. Sometimes, people starting an enterprise use their personal accounts for banking. It is typically better to seek out commercial banking and open separate accounts for business vs. personal finances. This simplifies record keeping and the payment of taxes, and it also helps keep these two realms separate in case of any legal action.

How Commercial Banking Works

Commercial banks serve small- to large-sized businesses. You may be familiar with their names, as many of them also have retail banking divisions. Three examples of commercial banks in the United States are JPMorgan Chase & Co., Bank of America Corp., and Wells Fargo & Co. All are regulated by the United States Federal Reserve, the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corporation (FDIC).

One very important function of commercial banks: providing financing to businesses. Before a commercial bank extends a loan to a business, it assesses the creditworthiness of the borrower by looking at its assets, profitability, and size.

In addition, commercial banks provide an array of services, supporting businesses with transfers from one account to another, lines of credit, lockbox services, payment processing, and foreign exchange services. Here, a closer look at what a commercial bank offers:

Deposit Accounts

Commercial bank deposit accounts function like retail bank checking and savings accounts. They enable businesses to pay suppliers and employees by holding cash and, in some cases, may earn interest on the balance.

There are three main types of deposit accounts: demand, fixed, and savings.

•   Account holders can use demand deposits or current account deposits for business transactions. They typically do not earn interest and are subject to service charges.

•   The bank holds fixed deposits for a specific term. Deposits likely earn interest, and the account holder can make withdrawals.

•   Savings deposits function as both fixed deposit and current accounts. Depositors can withdraw cash from these accounts, but the amount may be limited. Savings accounts earn interest but probably less than a fixed deposit.

Loans

Businesses need capital to thrive. Whether hiring staff, renting office or manufacturing space, or buying materials and supplies, operating a business and growing it takes cash. Commercial banks extend business loans vs. personal loans and charge interest on the loans. That’s one of the key income streams for banks, after all. The bank likely turns a profit on lending, and the business gets the funds it needs to launch their enterprise or to expand or buy real estate or new equipment.

Lines of Credit

Commercial banks usually provide businesses with lines of credit. A line of credit is short-term funding that can help a company manage its obligations while it waits for cash flow to improve. For example, a company may have to wait for receivables’ payment in order to meet this month’s payroll. A line of credit can help bridge that gap.

Letters of Credit

A business may need to request a letter of credit from a commercial bank to show their creditworthiness and to secure goods or services from an overseas trading partner. A letter of credit can serve as a guarantee from the issuing bank of payment for the goods once the letter’s requirements are met. The requirements might include the shipping date and the address the goods should be shipped to. In this way, a commercial bank can smooth international trade and help its clients’ business grow.

Lockbox Services

Lockboxes facilitate faster payments for businesses. Bank customers can send payments to a post office box near the bank, and the bank deposits the payments or funds to the customer’s account. This help expedite the receipt of deposits and subsequent payments from the client to its providers. It can be a very helpful cash flow tool for commercial enterprises.

Payment and Transaction Processing

Commercial banks typically facilitate the payments that businesses receive from their customers through electronic checks, paper checks, and credit card payments. Commercial banks may also provide services such as chargeback management fraud protection. All of these services can help keep a business humming along.

Foreign Exchange

Cross-border payments are complex because of exchange rates and the fact that each country has a different legal system. Commercial banks can provide foreign exchange services so that a company can do business overseas with a minimum of time and effort. This can really streamline operations for a business enterprise so they can focus their attention on other activities.

The Significance of Commercial Banks

Commercial banks play a vital role in the financial life of the U.S. They help support the country’s economy by providing capital and services to businesses. By providing loans, they likely allow businesses to increase production and potentially expand, which boosts the economy, lowers unemployment, and encourages consumer spending. In addition, commercial banks support cross-border trade and transactions (say, by issuing revolving letters of credit) so that businesses can operate in international markets.

Commercial Banking vs Investment Banking

When considering the definition of commercial banking, it can be helpful to compare and contrast it to other kinds of banking. You’ve learned above what commercial banking is all about. Investment banking, on the other hand, is a subset of banking that is focused on creating capital for companies, governments, and other organizations.

While some financial institutions may combine commercial and investment banking, thanks to the Gramm-Leach-Bliley Act of 1999, the two kinds of banking serve different markets. Here’s more detail of what investment banks do:

•   Underwriting

•   Overseeing mergers and acquisitions and initial public offerings (IPOs)

•   Facilitating reorganizations

•   Aiding in the sale of securities

•   Brokering trades for institutions and private investors

Commercial Banks vs Retail Banks

Another important distinction is how commercial banks differ from retail ones. Some banks will offer both sets of services, but here’s what retail banks likely offer in terms of personal banking services:

•   Savings and checking accounts (you can often open these bank accounts online)

•   Mortgages

•   Personal loans

•   Debit cards

•   Certificates of deposit (CDs)

There are also alternatives to traditional banking that can assist with personal finance transactions.

Examples of Commercial Banks

It can be helpful to have specific examples of commercial banks to better understand what they do and how they work. There are three types of commercial banks: public sector banks, private banks, and foreign banks.

•   A public sector bank is one where the government owns a major share. Public banks provide funding for projects that benefit the local public and community, which could include infrastructure projects or affordable housing. The Bank of North Dakota (BND) is the only active public bank in the United States.

•   Most of the banks in the United States are private banks run by individuals or limited partners. Examples are JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co.

•   A foreign bank is any bank headquartered in another country but doing business in the United States. Two examples are Barclays Bank PLC, headquartered in the United Kingdom, and Bank of Bahrain & Kuwait BSC.

Benefits of a Commercial Bank Account

There are several reasons a business should consider opening a commercial bank account.

•   Your clients are likely to feel more confident making payments for services rendered to a business rather than an individual. Simply put, it’s more professional and may be perceived as more trustworthy.

•   Having separate bank accounts for your business and personal transactions can simplify accounting and taxes (business expenses are more easily deducted).

•   If you face legal or financial challenges with your business activity, your personal liability can be limited and protected.

•   Your business can apply for business loans from a commercial bank and finance expansion or costly equipment purchases with favorable lending terms.

•   Business accounts are FDIC-insured in the event the bank fails.

Is My Bank a Commercial Bank?

If your bank provides services to businesses, such as checking accounts, financing, lines of credit, and international trade services, it is likely a commercial bank. A retail bank, on the other hand, will provide services to individuals (joint vs. separate accounts, debit cards, personal loans, and more) and could be a department within a commercial bank.

The Takeaway

Commercial banking differs from retail banking in terms of the clientele it serves. Retail banks provide checking and savings accounts, loans, and other services to individuals to manage their day-to-day finances. Commercial banks, however, help businesses launch, operate, and grow with services like deposit accounts, loans, lines of credit, payment services, and more. They are critical to keeping our economy humming along.

If you are hunting for personal banking services, check out what SoFi offers. Our online bank accounts can help your money grow faster. When you open our Checking and Savings with direct deposit, you’ll earn a competitive APY, pay no account fees, and have access to your paycheck up to two days early.

Better banking is here with SoFi, NerdWallet’s 2024 winner for Best Checking Account Overall. Enjoy up to 4.60% APY on SoFi Checking and Savings.

FAQ

What is the difference between commercial banking and retail banking?

Retail and commercial banking serve different clients. Retail banking provides checking and savings accounts, financing, lines of credit, credit cards, and other services to individuals. Commercial banking usually provides checking and savings accounts, financing, underwriting, letters of credit, lines of credit, and other functions to businesses.

Is my money safe in a commercial bank?

Your money is as safe in a commercial bank as it can be. It is protected from loss due to bank failure by federal insurance up to $250,000 for checking and savings accounts, trusts, and IRAs or certificates of deposit, and stock investments.

What role does a commercial bank play in the economy?

Commercial banks support the economy by providing capital and services to organizations. These, in turn, can stimulate the economy by doing business, growing, and employing more workers. Commercial banks also facilitate cross-border payments so that businesses can move into international markets.

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SoFi members with direct deposit activity can earn 4.60% annual percentage yield (APY) on savings balances (including Vaults) and 0.50% APY on checking balances. Direct Deposit means a deposit to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Direct Deposit”) via the Automated Clearing House (“ACH”) Network during a 30-day Evaluation Period (as defined below). Deposits that are not from an employer or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, do not constitute Direct Deposit activity. There is no minimum Direct Deposit amount required to qualify for the stated interest rate.

SoFi members with Qualifying Deposits can earn 4.60% APY on savings balances (including Vaults) and 0.50% APY on checking balances. Qualifying Deposits means one or more deposits that, in the aggregate, are equal to or greater than $5,000 to an account holder’s SoFi Checking and Savings account (“Qualifying Deposits”) during a 30-day Evaluation Period (as defined below). Qualifying Deposits only include those deposits from the following eligible sources: (i) ACH transfers, (ii) inbound wire transfers, (iii) peer-to-peer transfers (i.e., external transfers from PayPal, Venmo, etc. and internal peer-to-peer transfers from a SoFi account belonging to another account holder), (iv) check deposits, (v) instant funding to your SoFi Bank Debit Card, (vi) push payments to your SoFi Bank Debit Card, and (vii) cash deposits. Qualifying Deposits do not include: (i) transfers between an account holder’s Checking account, Savings account, and/or Vaults; (ii) interest payments; (iii) bonuses issued by SoFi Bank or its affiliates; or (iv) credits, reversals, and refunds from SoFi Bank, N.A. (“SoFi Bank”) or from a merchant.

SoFi Bank shall, in its sole discretion, assess each account holder’s Direct Deposit activity and Qualifying Deposits throughout each 30-Day Evaluation Period to determine the applicability of rates and may request additional documentation for verification of eligibility. The 30-Day Evaluation Period refers to the “Start Date” and “End Date” set forth on the APY Details page of your account, which comprises a period of 30 calendar days (the “30-Day Evaluation Period”). You can access the APY Details page at any time by logging into your SoFi account on the SoFi mobile app or SoFi website and selecting either (i) Banking > Savings > Current APY or (ii) Banking > Checking > Current APY. Upon receiving a Direct Deposit or $5,000 in Qualifying Deposits to your account, you will begin earning 4.60% APY on savings balances (including Vaults) and 0.50% on checking balances on or before the following calendar day. You will continue to earn these APYs for (i) the remainder of the current 30-Day Evaluation Period and through the end of the subsequent 30-Day Evaluation Period and (ii) any following 30-day Evaluation Periods during which SoFi Bank determines you to have Direct Deposit activity or $5,000 in Qualifying Deposits without interruption.

SoFi Bank reserves the right to grant a grace period to account holders following a change in Direct Deposit activity or Qualifying Deposits activity before adjusting rates. If SoFi Bank grants you a grace period, the dates for such grace period will be reflected on the APY Details page of your account. If SoFi Bank determines that you did not have Direct Deposit activity or $5,000 in Qualifying Deposits during the current 30-day Evaluation Period and, if applicable, the grace period, then you will begin earning the rates earned by account holders without either Direct Deposit or Qualifying Deposits until you have Direct Deposit activity or $5,000 in Qualifying Deposits in a subsequent 30-Day Evaluation Period. For the avoidance of doubt, an account holder with both Direct Deposit activity and Qualifying Deposits will earn the rates earned by account holders with Direct Deposit.

Members without either Direct Deposit activity or Qualifying Deposits, as determined by SoFi Bank, during a 30-Day Evaluation Period and, if applicable, the grace period, will earn 1.20% APY on savings balances (including Vaults) and 0.50% APY on checking balances.

Interest rates are variable and subject to change at any time. These rates are current as of 10/24/2023. There is no minimum balance requirement. Additional information can be found at https://www.sofi.com/legal/banking-rate-sheet.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

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